A home is one of the most significant investments that most people make in their lifetime. However, many people can’t afford to pay for a home upfront and must rely on a mortgage to finance the purchase. There are different types of mortgages available, including conventional and FHA loans. Here you can compare the basic differences between conventional and FHA loans to help you make an informed decision when buying a home.
Conventional Loans
A conventional loan is a mortgage that is not guaranteed or insured by a government agency, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). Instead, conventional loans are offered by private lenders, such as banks, credit unions, or mortgage companies and often sold to government sponsored entities (GSE’s). These include the Federal National Mortgage Association (FNMA) known as Fannie Mae and the Federal Home Loan Mortgage Corporation (FHLMC) known as Freddie Mac.
Conventional loans are popular among homebuyers because they typically offer lower interest rates and more flexible terms than government-backed loans. However, they also have higher requirements for credit scores and down payments.
Credit Score Requirements
Conventional loans usually require a higher credit score than government-backed loans. The minimum credit score requirement for a conventional loan is typically around 620, but some lenders may require a higher score.
Down Payment Requirements
Conventional loans generally require a higher down payment than government-backed loans. The down payment requirement for a conventional loan can range from 3% to 20% of the home’s purchase price, depending on the lender’s requirements and the borrower’s credit score. Borrowers with a lower credit score may need to put down a higher down payment to qualify for a conventional loan.
Mortgage Insurance Requirements
Conventional loans require private mortgage insurance (PMI) if the borrower puts down less than 20% of the home’s purchase price. PMI is a type of insurance that protects the lender if the borrower defaults on the loan. PMI typically costs between 0.3% to 1.5% of the loan amount per year and is added to the borrower’s monthly mortgage payment.
PMI can be canceled once the borrower has paid off 20% of the home’s purchase price, but borrowers may need to request its removal from the lender.
FHA Loans
An FHA loan is a mortgage that is insured by the Federal Housing Administration (FHA), a government agency that is part of the Department of Housing and Urban Development (HUD). FHA loans are designed to help low- to moderate-income borrowers buy a home with a smaller down payment and lower credit score requirements than conventional loans. It is designed to help individuals and families with lower credit scores or smaller down payments to buy a home.
To qualify for an FHA loan, borrowers must meet certain requirements:
- Credit Score: While there is no minimum credit score requirement, most lenders require a credit score of at least 580 to qualify for an FHA loan. Borrowers with a credit score between 500 and 579 may still be eligible but will need to provide a larger down payment.
- Down Payment: The down payment for an FHA loan is typically 3.5% of the purchase price. However, borrowers with a credit score below 580 may need to put down 10% of the purchase price.
- Assets used may come from a gift from a family member, nonprofit or a Down Payment Assistance (DPA) program.
- Income: Borrowers must have a steady income and be able to provide proof of employment for the past two years. Self-employed borrowers will need to provide additional documentation such as tax returns.
- Debt-to-Income Ratio: The debt-to-income ratio (DTI) is the percentage of monthly income that goes toward paying debts such as credit cards, car loans, and other mortgages. For an FHA loan, the maximum DTI is typically 43%, although some lenders may allow higher ratios under certain circumstances.
- Property Requirements: The property being purchased must be the borrower’s primary residence and must meet certain minimum property standards. These standards include things like proper ventilation, working heating and cooling systems, and a safe and sanitary living environment.
- Mortgage Insurance Premium (MIP): FHA loans require borrowers to pay an upfront mortgage insurance premium (UFMIP) at closing, as well as an annual mortgage insurance premium (MIP) that is added to the monthly mortgage payment. The MIP is required for the life of the loan unless the borrower refinances into a conventional loan.
- Loan Limits: FHA loan limits vary by county and are based on the median home price in the area. In some areas, the maximum loan amount for an FHA loan is $356,362 for a single-family home. However, in high-cost areas, the maximum loan amount can go up to $822,375. You can check your area for what the loan limits might be.
- Rates: These tend to be a little lower than conventional rates, however, this offsets the fact that there is upfront MIP that is tacked onto the loan amount and will end up equalizing any perceived advantage over the conventional loan.
In summary, to qualify for an FHA loan, borrowers must have a minimum credit score, meet income and debt-to-income requirements, put down a minimum down payment, and ensure the property meets minimum standards. Borrowers will also need to pay upfront and ongoing mortgage insurance premiums.
When comparing these two products, put them on a spreadsheet. If you are in a spot where you qualify for either one, see how the numbers shake out in terms of actual payment and how they will stack up over the length of time that you intend to be in your home. In the end you are the one that will have to make the payment and will glean the revenue from the earned equity at the time you sell.
If you have questions and are on the West Coast, please click the yellow bobble on the right and reach out. If you have in other states, find a local mortgage broker to assist you as you navigate the waters of homeownership.
Have helped buyers of all types and financial levels and worked on 1000's of loans.
There is always something new!
- Jumpin’ Jumbos – What is considered a BIG loan and how do you find one? - December 6, 2024
- You Can Buy A House in Many Ways - July 11, 2023
- How Much House Can I Afford? - July 11, 2023
